I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Tuesday, June 12, 2007

Overcoming Dependence

As long ago as 1945, when FDR met with Kind Ibn Saud aboard the USS Quincy, the US has made foreign oil dependency the cornerstone of its geopolitical strategy. No policy is left untouched by this choice: defence and domestic security, fiscal, monetary and economic development - all are heavily influenced by our need to secure and import ever growing volumes of foreign crude oil. The negative implications are profound and are currently becoming increasingly obvious: wars in the Middle East and Central Asia, terrorist attacks, the re-emergence of adversarial relationships between super-powers. Even the harmful effects to our environment is becoming an important topic when global leaders meet (eg the recent G8).

And yet, our foreign oil policy has not been without positive aspects, if dubious. The global thirst for oil priced in dollars has allowed the US to run up enormous deficits and debts without the need to maintain large foreign exchange reserves. The so-called Dollar Hegemony is based on the near-universal acceptance of our oil-backed currency and this, in turn, allows for the American Way of Life. If the US had not itself become the world's single largest importer and consumer of oil - the most indispensable and fungible commodity of them all - it is unlikely that the US dollar would possess the global reserve status it has today. Crude oil, the US dollar and the profound reach of American military and economic power have become inextricably linked.

But as remaining oil reserves become concentrated in the hands of fewer key producers, we are increasingly hostage to their desires and expectations, those quid pro quos that go beyond merely meeting the asking price in cash. Informed readers need no further elaboration; suffice it to say that just three countries, Saudi Arabia, Iraq and Iran control approximately 45% of global oil reserves. From a monetary policy perspective alone, it is extremely unwise to base the ultimate value of the dollar on such a narrow foundation - even before the very serious threat of geological Peak Oil.

What is to be done, purely from the viewpoint of monetary and fiscal policy? In order to retain the dollar's supreme position, the US must possess goods and services that the rest of the world wishes to buy and pay for in dollars. At this point nothing matches crude oil in such importance: if we were to suddenly replace oil with another source of energy not priced in dollars (eg solar or wind), the US economy would suffer mightily from the need to service so much debt without recourse to a universally accepted dollar.

But change we must: oil is running out and so is our ability to be the overwhelming influence-setter in the important oil and natural gas producing regions (e.g. Venezuela, Russia, Iran). Putting aside geologic considerations, if we do not soon replace oil as the main backing for our currency we will simply become yet another imperial has-been that is gradually impoverished from interest payments to foreign lenders and constant currency devaluation. Every great empire the world has ever seen has gone down that slippery route: Rome (West and East), the Ottomans, Spain, Great Britain, USSR. We, too, are not impervious to bad judgement and an over-abundance of false confidence when conditions change and actions are needed sooner, rather than later.

In my opinion, we must do two things, starting immediately:

a) Cut down on oil consumption via a significant fuel tax that will finance a modern Moon Shot-type project to replace every single watt generated by oil (foreign AND domestic) with solar, wind, nuclear, fusion, geothermal, or whatever else we come up with. Spend the money domestically and the economy will grow based on R&D and capital spending, instead of consuming imports. I am aware of the EROEI limitations of more diffuse energy sources, but that whole discussion misses the point: changing our energy regime is not something we could do, it's something we must do. The sooner we start the better the chances of adjusting our economy and society with few major disruptions.

b) Start reclaiming the manufacturing base of our domestic economy via a variety of positive and negative inducements (subsidies and import duties). Such industrial capabilities are absolutely necessary for the development and application of a new energy regime, one that will also create a range of highly lucrative export goods and services and thus support the value of the dollar. This is anathema to globalization adherents but, after all, globalization is itself entirely dependent on the ready availability of cheap energy (containerships and bulk carriers criss-crossing the oceans, state-subsidized energy in China, etc.). When that is taken away, whoever has an alternative-energy economy already in full operation will have a tremendous comparative advantage.

In closing, establishing a new US energy regime will benefit the economy, the environment and our national security and will help maintain the attractiveness of the dollar as a global reserve currency. Doing nothing is simply not an option.

We have to examine the perverse incentives offered too. The cost of maintaining the "Dwight D. Eisenhower National System of Interstate and Defense Highways" is extreme. Amtrak is being starved out of existence. Airlines and airports receive billions. Yet a tractor trailer must get 400 mpg to be as efficient as a freight train.

The funniest thing is Daimler Benz developed a system to allow multiple cars to whizz down the highway in a line with bumpers almost touching - they re-invented a train!

Answers:Cellulosic Ethanol, and plug in hybrids that burn it. Integrated public transport, where planes, trains, commuter rail and buses all work togeter. Pedestrian friendly mixed use development (new urbanism).

I saw a USDA study planning where the digesters should go, considering concentrated areas of waste cellulose, demand, and transportation costs.

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.